IRS Now Allows Caregiver Parents to Exclude Medicaid Waiver Payments From Income

The Internal Revenue Service has reversed a long-standing policy and agreed to allow parents of people with disabilities who receive Medicaid waiver funds in return for caregiving services provided to their children to exclude those funds from their incomes.

For years, the IRS has allowed foster parents to exclude "qualified foster care payments" from state agencies from their incomes, and foster parents of children with disabilities can also exclude so-called "difficulty of care" payments, which are funds provided to foster parents for the additional care provided to a child with disabilities. The excluded income does not count towards the taxpayer's gross income at all, making these payments essentially "tax free" funds.

In many states, biological parents of children with disabilities receive compensation from various Medicaid programs for the time they spend providing assistance to their children above and beyond what would be expected of parents of children without disabilities. However, the IRS has long fought biological parents who seek to exclude this income because, in the IRS's view, biological parents can never be "foster" parents and are not covered by the law, which only applies to "qualified foster care payments".

A new revenue notice, Notice 2014-7, changes this. Echoing claims that advocates have made for years, the notice explains that the law "does not explicitly address whether payments under Medicaid waiver programs are qualified foster care payments. Medicaid waiver programs and state foster care programs, however, share similar oversight and purposes. The purpose of Medicaid waiver programs and the legislative history of [the law] reflect the fact that home care programs prevent the institutionalization of individuals with physical, mental, or emotional handicaps. . . The programs share the objective of enabling individuals who otherwise would be institutionalized to live in a family home setting rather than in an institution, and both difficulty of care payments and Medicaid waiver payments compensate for the additional care required."

Because the IRS has finally recognized the objective behind Medicaid waiver payments, beginning on January 3, 2014, the IRS has begun to allow parents of children with disabilities to exclude qualified Medicaid waiver payments from income. It is unclear from the notice if parents who have not previously excluded Medicaid waiver income may amend previous tax returns to do so.

For more information about how you may be able to exclude Medicaid waiver income, talk to your special needs planner today.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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